What is the Worth of an Employee?
Prof. Paul A. Strassmann
George Mason University, April 17, 2006
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Ideas Emerging at End of 20th Century
•
•
•
•
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Knowledge Capital
Knowledge Assets
Knowledge Management
Intellectual Capital
Information Assets
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Payroll Expense Differs from Knowledge Assets
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Accepted Metrics Measure Returns on Finance Capital
Productivity =
Output
Input
Profit
Return-On-Equity =
Shareholder Equity
SOURCE OF WEALTH?
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Summary
• Financial statements account for only wages as an
expense.
• Financial balance sheets account for only net
financial assets, that is shareholder equity.
• The value of knowledge is reported only when a
company or its shares are sold.
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Theme of This Presentation
Only if you Can Measure Can You
Understand How to Invest.
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Outline of this Presentation I
Part I : Market Valuation of Knowledge Assets
Part II :Value-Added of Knowledge Capital
Part III : Special Studies
Part IV : Worth of Employees
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Shareholder Equity Cannot Explain the Sources of Wealth (FY2004)
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Market-Based Calculation of Knowledge Assets
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Market-Based Pricing of Knowledge Assets is Questionable
Wal-Mart Stock Prices - 2001 to 2006
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Summary
• Market Valuation of Knowledge Assets:
Market Valuation - Shareholder Equity
• Market Valuation of Knowledge Assets reveals the
inadequacies in financial reporting about the worth of a
firm.
• Market Valuation of Knowledge Assets offers a quick
approximation of the worth of Knowledge Capital.
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Outline of this Presentation II
Part I : Market Valuation of Knowledge Assets
Part II :Value-Added of Knowledge Capital
Part III : Special Studies
Part IV : Worth of Employees
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Fundamental Premises of the Information Age
• Equity Capital is a commodity. Readily available at
a price. It is not a source of competitive
advantage.
• In a successful firm Knowledge Capital will vastly
exceed Equity Capital.
• Knowledge Capital is the only source of
competitive advantage.
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Equity Capital vs. Knowledge Capital
Diminishing
Economies of Scale
For Equity Capital
Increasing
Economies of Scale for
Knowledge Capital
ue
Incremental Revenue
nta
me
ncre
I
ven
e
R
l
st
e
em
Incr
o
C
l
a
nt
Incre
ment
al Co
st
Scale of Output
Scale of Output
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Calculating the Value-Added Worth of Knowledge Capital
Productivity =
Output
Input
Knowledge Capital = Knowledge Value-Added
Cost of Equity Capital
SOURCE OF WEALTH
Knowledge Capital® is a Registered Trademark of Strassmann, Inc.
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
What is Knowledge Value-Added?
Knowledge Value-Added = Profit - Equity Rent
Where:
Equity Rent = Cost of Equity Capital * Equity
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Capital Asset Pricing Model - Cost of Equity Capital
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Knowledge Value-Added After Subtracting “Rent” for Equity
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Calculating the Intrinsic Worth of Knowledge Capital
Productivity =
Output
Input
Knowledge Capital = Knowledge Value-Added
Cost of Equity Capital
SOURCE OF WEALTH
Knowledge Capital® is a Registered Trademark of Strassmann, Inc.
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Knowledge Capital® Calculation Based on Value-Added
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Comparisons of Market-Based vs. Value-Added Knowledge Worth
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Knowledge Assets in the US Economy (1998 data,$ trillions)
Fin.
Assets
$0.5
Plant &
Property
$3.1
Corporate
Assets
$10.9
Knowledge
Assets - $7.4
Market
Valuation
$12.3
SOURCE: Strassmann, Inc. database of 5,763 US firms
Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
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Summary
• Value-Added valuation of Knowledge Capital
reflects a view that Equity Capital is available as a
risky commodity.
• Value-Added valuation is based on the generally
accepted Capital Asset Pricing Model (CAPM).
• Value-Added valuation links actual financial results
to an estimate of Knowledge Capital as “surplus
value.”
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Outline of this Presentation III
Part I : Market Valuation of Knowledge Assets
Part II :Value-Added of Knowledge Capital
Part III : Special Studies
Part IV : Worth of Employees
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
GM as a Case Study
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Market Value and Cumulative SG&A - Abbott Laboratories
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Knowledge Accumulation Efficiency Affects Employee Worth
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Summary
• Knowledge valuations offer a wide range of
analytic methods for evaluating the results
delivered by information technologies.
• Knowledge asset tracking suggests that market
valuations may reflect the effective investments in
the management of information resources.
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Outline of this Presentation IV
Part I : Market Valuation of Knowledge Assets
Part II :Value-Added of Knowledge Capital
Part III : Special Studies
Part IV : Worth of Employees
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
The Top 10 “Smartest” U.S. Firms, out of 5,253 (FY 2004)
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Biggest US Firms Do not Rank in the Top 20 Smartest List
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Worth of Employees, Pharmaceutical Firms
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Assumptions About the Valuation of the Worth of Knowledge
• Employees are a risky asset.
• The annual worth of an employee asset reflects a
firm’s risks in obtaining capital, multiplied by the
stock market’s assessment of the “smartness” of
a firm:
Market Value
Capital Asset Pricing Model *
Shareholder Equity
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Annual Worth of Employee Knowledge Assets
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Net Worth = Difference Between Knowledge and Compensation
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Summary
• Two methods for calculating the worth of knowledge
assets are available.
• Knowledge assets have become the dominant corporate
assets.
• Comparison of knowledge assets can be used for
competitive benchmarking.
• Effective organizations accumulate knowledge assets.
• Knowledge asset accumulation, not only efficiencies in the
uses of information technologies, can become a metric for
evaluating CIO performance.
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
General Information
• Videos of all Strassmann GMU lectures now available
on http://video.google.com/videosearch?q=strassmann
• Questions about this presentation can be addressed
to [email protected]
• Next lecture will be “Systems Transformation
Technologies.”
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Prof. Strassmann, GMU April 17, 2006 Lecture, REPRODUCED BY PERMISSION ONLY